nep-opm New Economics Papers
on Open Economy Macroeconomics
Issue of 2015‒02‒22
twenty-two papers chosen by
Martin Berka
University of Auckland

  1. International Financial Market Integration, Asset Compositions and the Falling Exchange Rate Pass-Through By Enders, Zeno; Buzaushina, Almira; Hoffmann, Mathias
  2. Effective exchange rates, current accounts and global imbalances By Beckmann, Joscha; Czudaj, Robert
  3. Asset bubbles and sudden stops in a small open economy By Alberto Martin; Jaume Ventura
  4. International Capital Flows, External Assets, and Output Volatility By Krause, Michael; Hoffmann, Mathias; Tillmann, Peter
  5. Fluctuations of the Real Exchange Rate, Real Interest Rates, and the Dynamics of the Price of Gold in a Small Open Economy By Rohloff, Sebastian; Pierdzioch, Christian; Risse, Marian
  6. Interest Rates and Structural Shocks in European Transition Economies By Mirdala, Rajmund
  7. Was the Classical Gold Standard Credible on the Periphery? Evidence from Currency Risk By Mitchener, Kris; Weidenmier, Marc
  8. Is Real Exchange Rate Hedging Motive Still Important in Determining Equity Home Bias? By Stewen, Iryna
  9. News Shocks in Open Economies: Evidence from Giant Oil Discoveries By Rabah Arezki; Valerie A. Ramey; Liugang Sheng
  10. The franc shock and Swiss GDP: How long does it take to start feeling the pain? By Boriss Siliverstovs
  11. The Relevance of International Spillovers and Asymmetric Effects in the Taylor Rule By Beckmann, Joscha; Belke, Ansgar; Dreger, Christian
  12. The Mode of Competition between Foreign and Domestic Goods, Pass-Through, and External Adjustment By Raphael Schoenle; Raphael Auer
  13. A Pairwise-Based Approach to Examine the Feldstein-Horioka Condition of International Capital Mobility By Mark J. Holmes; Jesús Otero
  14. Information Globalization, Risk Sharing, and International Trade By Mike Waugh; Laura Veldkamp; Isaac Baley
  15. Analysis of Monetary Policy Responses after Financial Market Crises in a Continuous Time New Keynesian Model By Niehof, Britta; Hayo, Bernd
  16. International Asset Allocations and Capital Flows: The Benchmark Effect By Claudio Raddatz; Sergio L. Schmukler; Tomas Williams
  17. Global Liquidity, House Prices, and the Macroeconomy: Evidence from Advanced and Emerging Economies By Ambrogio Cesa-Bianchi; Luis Felipe Cespedes; Alessandro Rebucci
  18. On the Efficiency of the World Capital Allocation By Raul Santaeulalia-Llopis; Juan Sanchez; Alexander Monge
  19. Dutch Disease and the Mitigation Effect of Migration: Evidence from Canadian Provinces By Wessel Vermeulen; Michel Beine; Serge Coulombe
  20. Renegotiation and the Maturity Structure of Sovereign Debt By Ananth Ramanarayanan
  21. Networked default: public debt, trade embeddedness, and partisan survival in democracies since 1870 By Jeffrey Chwieroth; Cohen Simpson; Andrew Walter
  22. The Internationalization of the RMB, Capital Market Openness, and Financial Reforms in China By Joshua Aizenman

  1. By: Enders, Zeno; Buzaushina, Almira; Hoffmann, Mathias
    Abstract: This paper provides an explanation for the observed decline of exchange rate pass-through into import prices by modeling the effects of financial market integration on the optimal choice of the pricing currency in the context of rigid nominal goods prices. Contrary to previous literature, the interdependence of this choice with an optimal portfolio choice of internationally traded financial assets is explicitly taken into account. In particular, price setters move towards more local-currency pricing while the debt portfolio includes more foreign assets following increased financial integration. Both predictions are in line with novel empirical evidence.
    JEL: F41 F36 F31
    Date: 2014
  2. By: Beckmann, Joscha; Czudaj, Robert
    Abstract: This study analyzes the dynamics between real e ective exchange rates and current account patterns from a novel perspective. We start by dissecting long-run and time-varying short-run dynamics between both variables. Following this, we extend our framework by including interest rates into our analysis. Finally, we examine common exchange rate and current account dynamics based on common factors derived from a principal components analysis. Our results show that a real appreciation is positively related to a worsening of the current account in most cases. The adjustment pattern is time-varying but suggests that the causality mainly runs from e ective exchange rates to current accounts and occurs through valuation e ects. However, an extension of our framework based on monthly data shows that trade balance adjustment is observed less frequently. From a global point of view, cross-country trends which drive exchange rates and current accounts also share similar dynamics over the long-run.
    JEL: F31 F32 G15
    Date: 2014
  3. By: Alberto Martin; Jaume Ventura
    Abstract: We live in a new world economy characterized by financial globalization and historically low interest rates. This paper presents a simple analytical framework that helps us understand how this new world economy works from the perspective of an emerging economy. Financial globalization gives rise to episodes of large capital inflows followed by sudden stops. Low international interest rates give rise to asset bubbles that pop and burst. The analysis provides novel answers to old questions: What are the effects of asset bubbles on capital flows and macroeconomic performance? How do these effects vary in normal times and during sudden stops? How should policymakers manage capital flows in this new environment?
    Keywords: financial globalization, international capital flows, sudden stops, asset bubbles, capital controls.
    JEL: E32 E44 O40
    Date: 2014–09
  4. By: Krause, Michael; Hoffmann, Mathias; Tillmann, Peter
    Abstract: This paper proposes a new perspective on international capital flows and countries' long-run external asset position. Cross-sectional evidence for 84 developing countries shows that over the last three decades countries that have had on average higher volatility of output growth: (1) accumulated higher external assets in the long-run and (2) experienced more procyclical capital outflows over the business cycle than those countries with a same growth rate but a more stable output path. We explain this finding with a stochastic real business cycle growth model in which higher uncertainty of expected income increases households' precautionary savings. In the model, the combination of income risk and the precautionary savings motive leads to procyclical capital outflows at business cycle frequency and a higher long-run external asset position.
    JEL: F32 D83 F44
    Date: 2014
  5. By: Rohloff, Sebastian; Pierdzioch, Christian; Risse, Marian
    Abstract: Economic theory predicts that, in a small open economy, the dynamics of the real price of gold should be linked to real interest rates and the rate of change of the real exchange rate. Using data for Australia, we use a real-time forecasting approach to analyze whether real interest rates and the rate of change of the real exchange rate help to forecast out-ofsample the rate of change of the real price of gold. We study the economic value-added of out-of-sample forecasts using a behavioral-finance approach that takes into account that a forecaster may have an asymmetric loss function.
    JEL: C53 E44 G12
    Date: 2014
  6. By: Mirdala, Rajmund
    Abstract: European transition economies are still suffering from negative implications of economic crisis. Significant decrease in the key interest rates was followed by reduced maneuverability of central banks in providing incentives into real economies. Low interest rate environment together with effects of quantitative easing induced economists to examine sources of interest rates volatility. Responsiveness of short-term interest rates to the structural shocks provides unique platform to investigate sources of their unexpected volatility and associated effects on monetary policy decision making. Moreover, sources of interest rates volatility may help to reveal side effects of the exchange rate regime choice. Empirical investigation of interest rates determination under different exchange rate regimes highlights substantial implications of relative exchange rate diversity and its importance during the crisis period. In the paper we analyze sources of the short-term nominal interest rates volatility in ten European transition economies by employing SVAR methodology. We observed unique patterns of the short-term interest rates responsiveness in countries with different exchange rate arrangements that contributes to the fixed versus flexible exchange rate dilemma.
    Keywords: interest rates, structural shocks, exchange rate arrangements, economic crisis, VAR, impulse-response function
    JEL: C32 E43 F41
    Date: 2014–08
  7. By: Mitchener, Kris; Weidenmier, Marc
    Abstract: We use a standard metric from international finance, the currency risk premium, to assess the credibility of fixed exchange rates during the classical gold standard era. Theory suggests that a completely credible and permanent commitment to join the gold standard would have zero currency risk or no expectation of devaluation. We find that, even five years after a typical emerging-market country joined the gold standard, the currency risk premium averaged at least 220 basis points. Fixed- effects, panel-regression estimates that control for a variety of borrower-specific factors also show large and positive currency risk premia. In contrast to core gold standard countries, such as France and Germany, the persistence of large premia, long after gold standard adoption, suggest that financial markets did not view the pegs in emerging markets as credible and expected devaluation.
    Keywords: currency risk; fixed exchange rates; gold standard; sovereign borrowing
    JEL: F22 F33 F36 F41 N10 N20
    Date: 2015–02
  8. By: Stewen, Iryna
    Abstract: The majority of general equilibrium models of international portfolio holdings differ substantially in their modeling procedures but typically feature a term that captures the relationship between real exchange rate changes and relative, i.e. home vs. foreign, equity market returns. However, there is no consensus among the general equilibrium models on the sign of the exchange rate relative equity return relation. Recent empirical evidence focused on the US vis- -vis the rest-of-the world has not provided clear guidance in this respect. This paper fills this gap by taking a broader, international perspective. The evidence points to strong and significantly positive relative equity market return real exchange rate relations for non-EMU developed markets as well as emerging markets. The sign is as expected from standard, partial equilibrium models of home bias in international portfolio holdings. I further show that this evidence is strongly linked to countries trade and financial openness.
    JEL: G11 F21 F41
    Date: 2014
  9. By: Rabah Arezki; Valerie A. Ramey; Liugang Sheng
    Abstract: This paper explores the effect of news shocks on the current account and other macroeconomic variables using worldwide giant oil discoveries as a directly observable measure of news shocks about future output - the delay between a discovery and production is on average 4 to 6 years.  We first present a two-sector small open economy model in order to predict the responses of macroeconomic aggregates to news of an oil discovery.  We then estimate the effects of giant oil discoveries on a large panel of countries.  Our empirical estimates are consistent with the predictions of the model.  After an oil discovery, the current account and saving rate decline for the first 5 years and then rise sharply during the ensuing years.  Investment rises robustly soon after the news arrives, while GDP does not increase until after 5 years.  Employment rates fall slightly for a sustained period of time.
    Keywords: news shocks, curent account, saving, investment, employment, oil, discovery
    JEL: E00 F3 F4
    Date: 2015–01–12
  10. By: Boriss Siliverstovs (KOF Swiss Economic Institute, ETH Zurich, Switzerland)
    Abstract: The paper addresses the question on what is the typical time horizon over which a full transmission of movements in the real exchange rate into real economy takes place. To this end, we base our analysis on the mixed-frequency small-scale dynamic factor model of Siliverstovs (2012) fitted to the Swiss data. In this paper, we augment the benchmark model with the real exchange rate of the Swiss franc vis-a-vis currencies of its 24 trading partners, while keeping the rest of model specification intact. We are interested in investigating the relationship between the common latent factor, representing the Swiss business cycle, and the real exchange rate. We explore the temporal relationship between these two variables by varying the time lag with which the real exchange rate enters the factor model by recording magnitude and statistical signicance of the factor loading coefficient in the equation pertaining to the real exchange rate variable. Our main conclusion is that the fluctuations in the exchange rate start influencing real economy after one month and their effect is practically over after thirteen months. The largest eect is recorded at the time horizon of about six to nine months.
    Keywords: mixed-frequency data, factor model, GDP growth, exchange rate, Factor model, Mixed-frequency data
    JEL: C22 E32
    Date: 2015–02
  11. By: Beckmann, Joscha; Belke, Ansgar; Dreger, Christian
    Abstract: Deviations of policy interest rates from the levels implied by the Taylor rule have been persistent before the financial crisis and increased especially after the turn of the century. Compared to the Taylor benchmark, policy rates were often too low. This paper provides evidence that both international spillovers, for instance international dependencies in the interest rate-setting of central banks, and nonlinear reaction patterns can offer a more realistic specification of the Taylor rule in the main industrial countries. The inclusion of international spillovers and, even more, nonlinear dynamics improves the explanatory power of standard Taylor reaction functions. Deviations from Taylor rates tend to be smaller and their negative trend can be eliminated.
    Date: 2015–02
  12. By: Raphael Schoenle (Brandeis University); Raphael Auer (Swiss National Bank)
    Abstract: We introduce Armington's (1969) notion of "origin differentiation" into a micro-founded model of pricing to market and examine how this affects the joint dynamics of prices and quantities in an international real business cycle framework. We find that the model, when calibrated using parameters that we structurally estimate from micro data on U.S. domestic and import prices, can match both movements in international relative prices and quantities as observed in the data. The mechanism that drives our results is that a moderate degree of substitutability between origins, combined with a high degree of substitutability between varieties from the same origin implies substantial variability in the markups of importers and limited spillovers into domestic prices, while at the same time it is consistent with a muted quantity response to such pronounced movements in relative prices.
    Date: 2014
  13. By: Mark J. Holmes (University of Waikato); Jesús Otero (Universidad del Rosario)
    Abstract: We propose a pairwise procedure to test the Feldstein-Horioka condition of capital mobility. In contrast to the existing approach, we explicitly examine the relationship between domestic investment and foreign savings rather than domestic savings. In terms of addressing the Feldstein-Horioka puzzle, our results based on a panel of OECD and emerging market economies initially suggests that the depth and extent of capital mobility remains generally limited, and that mobility has increased over the past twenty years. However, in contrast to existing studies, we find that capital mobility between Euro and EU pairs is more extensive than between pairs that involve other countries. If our sample is expanded to include emerging markets, we find that capital mobility has also increased though is weaker than for OECD economies. We provide additional insight in terms of consistency between our assessment of capital mobility based on the Feldstein-Horioka condition (a quantity approach) and a price approach based on real interest rate differentials.
    Keywords: Feldstein-Horioka; capital mobility; pairwise real interest rates
    JEL: F3 F4
    Date: 2015–01–31
  14. By: Mike Waugh (New York University); Laura Veldkamp (NYU Stern); Isaac Baley (New York University)
    Abstract: This paper studies the effect of reductions in information asymmetry - information globalization - on international risk sharing and trade flows. Information frictions are often invoked to explain low levels of international trade beyond those that measured trade frictions (tariffs, transportation costs, etc.) can explain. Using a relatively standard two-country general equilibrium model with asymmetric information about aggregate productivity, we find that more precise information about foreign productivity shocks reduces trade and international risk sharing. In other words, information frictions behave in the exact opposite manner as a standard trade cost.
    Date: 2014
  15. By: Niehof, Britta; Hayo, Bernd
    Abstract: We develop a dynamic stochastic full equilibrium New Keynesian model of two open economies based on stochastic differential equations to analyse the interdependence between monetary policy and financial markets in the context of the recent financial crisis. The effect of bubbles on stock and housing markets and their transmission to the domestic real economy and the contagious effects on foreign markets are studied. We simulate adjustment paths for the economies under two monetary policy rules: an open-economy Taylor rule and a modified Taylor rule, which takes into account stabilisation of financial markets as a monetary policy objective. We find that for the price of a strong hike in inflation a severe economic recession can be avoided under the modified rule. Using Bayesian estimation techniques, we calibrate the model to the case of the United States and Canada and find that the resulting
    JEL: C02 E44 F41
    Date: 2014
  16. By: Claudio Raddatz (Central Bank of Chile); Sergio L. Schmukler (World Bank and Hong Kong Institute for Monetary Research); Tomas Williams (Universitat Pompeu Fabra)
    Abstract: We study different channels through which well-known benchmark indexes impact asset allocations, capital flows, and asset prices across countries, using unique monthly micro-level data of benchmark compositions and mutual fund investments during 1996-2014. Benchmarks are useful for identification and have important effects on equity and bond mutual fund portfolios, including both passive and active funds. Benchmark effects are important after controlling for industry, macroeconomic, and country-specific time-varying effects. Reverse causality and common shocks do not drive the results. Exogenous, pre-announced changes in benchmarks result in movements in asset allocations and capital flows mostly when these changes are implemented. Moreover, assets in the benchmarks experience abnormal returns when benchmark changes become effective, suggesting that the reallocations implied by those changes are not immediately arbitraged away. By impacting country allocations, benchmarks explain apparently counterintuitive movements in capital flows and asset prices, for example, generating outflows and depressing prices in countries being upgraded.
    Keywords: Benchmark Indexes, Contagion, Coordination Mechanism, ETFs, International Asset Prices, International Portfolio Flows, Mutual Funds
    JEL: F32 F36 G11 G15 G23
    Date: 2015–02
  17. By: Ambrogio Cesa-Bianchi; Luis Felipe Cespedes; Alessandro Rebucci
    Abstract: In this paper we first compare house price cycles in advanced and emerging economies using a new quarterly house price data set covering the period 1990-2012. We find that house prices in emerging economies grow faster, are more volatile, less persistent and less synchronized across countries than in advanced economies. We also find that they correlate with capital flows more closely than in advanced economies. We then condition the analysis on an exogenous change to a particular component of capital flows. We find that a global liquidity shock, identified by aggregating bank-to-bank cross border flows and by using the external instrumental variable approach of Stock and Watson (2012) and Mertens and Ravn (2013), has a much stronger impact on house prices and consumption in emerging markets than in advanced economies. In our empirical model, holding house prices or the exchange rate constant in response to this shock tends to dampen its effects on consumption in emerging economies.
    Keywords: Housing prices;Business cycles;Capital flows;International liquidity;Emerging markets;Developed countries;Capital flows, emerging markets, global liquidity, house prices, external instrumental variables
    Date: 2015–01–29
  18. By: Raul Santaeulalia-Llopis (Washington University in St. Louis); Juan Sanchez (Federal Reserve Bank of St. Louis); Alexander Monge (Penn State University)
    Abstract: In this paper, we use an extended version of the neoclassical multi-country growth model to explore the efficiency in the allocation of physical capital across countries. In our framework, the observed marginal product of capital (MPK) can differ across countries because of two different factors: (a) differences in the countries' production functions, specifically output shares of mobile factors; and (b) differences in the distortions (wedges) in the use of capital across countries. We use the model to evaluate the importance of these two factors in accounting for the cross-country dispersion in the implied MPKs over the last 40 years and assess how efficiently capital is and has been allocated. Our findings indicate that in the last two decades the world has decidedly moved in the direction of efficiency. Moreover, we find that a realigment of capital to countries with higher TFP and capital-output shares accounts for a large fraction of the gains in efficiency. However, we find that even today, distortions (factor b) are still quantitatively significant and that the global output gains are would be significant if those distortions were eliminated. The gains are even larger in policy counterfactuals with capital accumulation. We also find a large degree of heterogeneity. For example, we find significant output loses for countries which heavily distort international trade and for countries with weak financial markets.
    Date: 2014
  19. By: Wessel Vermeulen; Michel Beine; Serge Coulombe
    Abstract: This paper evaluates whether immigration can mitigate the Dutch disease effects associated with booms in natural resource sectors.  We derive predicted changes in the size of the non-tradable sector from a small general-equilibrium model a la Obstfeld-Rogoff.  Using data for Canadian provinces, we find evidence that aggregate immigration mitigates the increase in the size of the non-tradable sector in booming regions.  The mitigation effect is due mostly to interprovincial migration and temporary foreign workers.  There is no evidence of such an effect for permenent international immigration.  Interprovincial migration also results in a spreading effect of Dutch disease from booming to non-booming provinces.
    Keywords: Natural Resources, Dutch Disease, Immigration, Mitigation Effect
    JEL: F22 O15 R11 R15
    Date: 2015–01–06
  20. By: Ananth Ramanarayanan (University of Western Ontario)
    Abstract: Sovereign debt defaults are accompanied by debt restructurings that alter the quantity as well as the maturity structure of a country's external debt. In a debt restructuring, the burden of repayment for a defaulting borrower can be reduced either by reducing the face value of debt or extending its maturity. Existing work on sovereign debt renegotiation focuses only on reduction of face value, while leaving the maturity structure constant. This paper builds a model of sovereign borrowing and renegotiation in which both the level of restructured debt and its maturity are outcomes of post-default renegotiation. A sovereign borrower borrows in international financial markets from competitive, risk-neutral lenders, and may default on debt at any time. After a default, the sovereign borrower and lenders bargain to choose both a new face value of debt and a new maturity structure. The paper quantitatively analyzes how the optimal restructuring agreement varies with the borrower's income in default, and how the presence of renegotiation of maturity affects borrowing and default incentives ex ante.
    Date: 2014
  21. By: Jeffrey Chwieroth; Cohen Simpson; Andrew Walter
    Abstract: Sovereign default is often associated with the downfall of incumbent governments in democratic polities. Existing scholarship directs attention to the relationship between default and domestic politics and institutions rather than the broader international environment wherein repayment and default take place. We explore the possibility that the impact of a country’s decision to default on partisan survival will also be shaped by the prevalence of default amongst its peers in its local network. Illustrating this line of reasoning with international trade, our results support the argument that given networked default, voters see national default as a lost strategic opportunity to elevate a country’s reputation and are more inclined to punish incumbent regimes who fail to repay. These results are inconsistent with an alternative possibility — that networked default might contribute to the decay of a repayment norm and thus provide a justifiable “excuse” for default at home. Furthermore, our results are robust to alternative measures of regime governance and entropy balancing in light of systematic differences between defaulting and non-defaulting regimes. Overall, our findings point to the political interdependence of default and repayment and the need for political scientists to take greater account of network effects in analyzing the consequences of economic misbehavior.
    Keywords: Sovereign Default; Debt Crises; Political Survival; Networks; Voter Behavior.
    JEL: H63
    Date: 2014–09
  22. By: Joshua Aizenman
    Abstract: This paper provides an overview of Chinese financial and trade integration in recent decades, and the challenges facing China in the coming years. China had been a prime example of exported growth, benefiting from learning by doing, and by adopting foreign know-how, supported by a complex industrial policy. While the resultant growth has been spectacular, it comes with hidden but growing costs and distortions. The Chinese export-led growth path has been challenged by its own success, and the Global Financial Crisis forced China toward rebalancing, which is a work in progress. Reflecting on the internationalization of the CNY, one expects the rapid accelerating of the commercial internationalization of the CNY.
    JEL: F3 F32 F36 F4 F41
    Date: 2015–02

This nep-opm issue is ©2015 by Martin Berka. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.